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Greenspan: Watch risk
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May 4, 2000: 9:51 a.m. ET
Fed chairman steers clear of rate policy comments in speech to bankers
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NEW YORK (CNNfn) - Federal Reserve Chairman Alan Greenspan warned U.S. bankers Thursday that they must not be lulled into complacency in managing risks, especially with sophisticated financial tools such as derivatives.
Speaking at a banking conference in Chicago, Greenspan steered clear of discussing the outlook for U.S. interest rates or the economy. Fed watchers are closely monitoring Greenspan's comments ahead of a May 16 Federal Reserve policymakers meeting that could lead to another interest rate increase.
While the Fed chairman declined to speculate on interest rates, Federal Reserve Bank of San Francisco President Robert Parry said the Fed should follow its course of gradual rate increases to ease threats of inflation.
"It's risky just to sit back and wait for an upward trend in inflation to show up before we do something," Parry, a voting member of the Fed's policymaking Federal Open Market Committee, said in a Seattle speech to financial analysts.
"At the same time, we need to proceed with some caution, because there's a fair bit of uncertainty about the economy's behavior right now," Parry added.
Greenspan said new financial tools are providing benefits for the country overall, but warned banks that they should not become overconfident about risks. (WAV259K) (AIF259K)
 "The possibility that market participants are developing a degree of complacency or a feeling that technology has inoculated them against market turbulence is admittedly disquieting," he said. "Such complacency is not justified."
Derivatives are complex financial instruments used by businesses to guard against losses from unexpected shifts in the markets. These tools played a major role in the near-collapse in September 1998 of hedge fund Long-Term Capital Management, which
used derivatives for speculative investments.
So far, Greenspan said, bank losses from their derivatives holdings have been small, but he said that does not mean they should not be cautious going forward.
"The rapid growth and increasing importance of derivative instruments in the risk profile of many large banks has been a particular concern," Greenspan said.
He said market participants should not rely on the Fed to bail them out in the event of a bank failure.
"We must be careful not to foster an expectation that policymakers will ultimately solve all serious potential problems and disruptions," he said.
In the event of a failure, "shareholders would not be protected, and I would envision appropriate discounts or 'haircuts' for other than federally insured liabilities," he said.
Greenspan also called for more disclosure in the financial sector so that banks can be better able to prevent risks.
"The issue of disclosure is not just a minor interesting aspect of banking. It's going to turn out to be, as the years go on, as crucial an aspect in finance as it's increasingly becoming the case in industry," he said.
--From staff and wire reports 
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